<strong><em>Estate of Edward I. Rieben, Deceased, Philip Rieben and Leo J. Margolin, Executors, Petitioner, v. Commissioner of Internal Revenue, Respondent, 32 T.C. 1205 (1959)</em></strong>

A lump-sum distribution from a pension plan is only eligible for capital gains treatment under Section 165(b) of the 1939 Internal Revenue Code if it is made “on account of the employee’s separation from service” and represents a complete severance of the employment relationship.

<strong>Summary</strong>

The Estate of Edward Rieben challenged the Commissioner’s assessment that the cash proceeds from an annuity policy, distributed to Rieben from his company’s pension plan, should be taxed as ordinary income rather than capital gains. The Tax Court ruled in favor of the Commissioner, holding that Rieben’s receipt of the annuity proceeds did not qualify for capital gains treatment because it was not distributed “on account of the employee’s separation from the service.” Rieben continued his employment with the company even after the business discontinued its swimwear operations and dissolved its pension plan. Therefore, the court determined that the distribution was made due to the pension plan’s termination, not Rieben’s separation from employment.

<strong>Facts</strong>

Edward I. Rieben was president and a shareholder of Lee Knitwear Corp. The company established a pension fund in 1943. Rieben participated in the pension plan. In 1952, the company decided to discontinue its swimwear business, which led to the termination of the pension trust. Rieben received an annuity policy from the pension trustees on September 25, 1952, and subsequently received the cash proceeds of $25,170.75 on November 10, 1952. Rieben continued to be a stockholder, president, and director of Lee Knitwear until his death. The company continued in operation, mainly for investment purposes. Rieben reported the proceeds as a long-term capital gain, but the Commissioner determined it was ordinary income.

<strong>Procedural History</strong>

The Commissioner of Internal Revenue determined a tax deficiency against the Estate of Edward Rieben. The Estate contested this determination in the United States Tax Court. The Tax Court reviewed the case and issued a decision in favor of the Commissioner, concluding that the distribution of the annuity policy proceeds did not qualify for capital gains treatment.

<strong>Issue(s)</strong>

1. Whether the cash proceeds from the annuity policy received by Rieben were taxable as long-term capital gains under Section 165(b) of the Internal Revenue Code of 1939?

<strong>Holding</strong>

1. No, because the evidence failed to show that either the cash or the annuity contract was received by Rieben as a distribution from the pension plan or trust on account of his separation from the service of Lee Knitwear.

<strong>Court’s Reasoning</strong>

The Court examined the requirements for capital gains treatment of pension distributions under Section 165(b) of the 1939 Internal Revenue Code. The statute states that a distribution must be made “on account of the employee’s separation from the service” to qualify for capital gains treatment. The court emphasized that such a separation must entail a complete termination of the employment relationship. The court found that Rieben did not sever his connection with Lee Knitwear. He remained an officer and shareholder. Though the company had discontinued its swimwear business, it remained in operation. The court concluded the distribution was a consequence of the pension plan’s termination rather than Rieben’s separation from employment. The Court stated: “The record fails to show that either the cash or the annuity contract was received by Edward as a distribution from the pension plan or trust on account of his separation from the service of Knitwear.”

<strong>Practical Implications</strong>

This case emphasizes that, for a distribution from a qualified pension plan to receive capital gains tax treatment, the separation from service must be complete. Mere cessation of certain job duties (such as the swimwear business) does not satisfy the requirement. This ruling has practical implications for employers and employees regarding tax planning for retirement distributions. Individuals in similar circumstances must demonstrate a genuine, total severance from employment to claim the favorable tax treatment. It also underscores the importance of the precise language in pension plan documents, as the court examined the specific terms of the plan. The case guides legal practitioners in advising clients on how to structure employment separations and pension plan distributions to maximize potential tax benefits. Future cases would likely focus on how “separation from service” is defined under current tax regulations and the nature of the employment relationship post-distribution.